Fed Expected To Cut Interest Rates, Though Inflation May Be Picking Up

WASHINGTON, DC – SEPTEMBER 18: Federal Reserve Chairman Jerome Powell speaks during a news conference following the September meeting of the Federal Open Market Committee at the William McChesney Martin Jr. Federal Reserve Board Building on September 18, 2024 in Washington, DC. The Federal Reserve announced today that they will cut the central bank’s benchmark interest rate by 50 basis points to a new range of 4.75%-5%. (Photo by Anna Moneymaker/Getty Images)

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Fixed income markets fully expect that the Federal Open Market Committee will cut interest rates on September 17. However, economic data suggests that the FOMC may have to manage a monetary policy trade-off over the coming months.

That’s because the jobs market appears to have been weakening between May and July. That would typically call for lower rates. However, inflation may be picking up slightly on recent data. If that trend continues it might imply higher rates are needed. Of course, the FOMC only has a single policy tool, interest rates, so if unemployment rises and inflation picks up, then the FOMC’s decision making may be made more complicated.

Soft Jobs Data

The July Employment Situation Report saw 73,000 nonfarm payrolls added for July, which was itself a relatively slow pace of growth compared to prior months. However, figures for May and June were also revised down significantly to under 20,000 nonfarm payrolls added in both cases. In contrast, over 100,000 jobs had been added monthly over most of the prior 2 years. That said, the unemployment rate has been relatively stable since summer 2024, but if the recent slow pace of job creation continues, it may signal downside risk for the economy. The jobs report for August will be released on September 5, offering further data before the FOMC next meets.

Signs of Accelerating Inflation

Recent data has shown some acceleration of inflation, too. July Producer Price Indexes showed a relatively pronounced rise in prices. In addition, there were some signs of rising prices in the July Consumer Price Index. For now, overall inflation remains relatively mild. For example, annual inflation is close to 3% to July depending on the metric used. However, the FOMC’s annual target is 2% and inflation could accelerate further as the impact of tariffs, which in many cases have only been recently implemented, are felt.

That said, some policymakers have said they are willing to look through any tariff-related inflation, believing it will be one-off in nature. If so, that makes it an easier decision to lower rates if there are concerns about a softening job market.

Recent Dissents

At the last FOMC meeting in July both Christopher Waller and Michelle Bowman dissented, preferring to lower rates. That and the likely appointment of Stephen Miran to the FOMC before the September meeting, suggest added pressure for a rate cut. That’s because President Trump is known to favor lower rates, and he likely proposed Miran with the belief that he would vote to lower rates.

What To Expect

It seems likely that the FOMC will cut interest rates in September. There are still more economic reports to come before that meeting, but fixed income markets strongly predict a rate cut. That said, there are signs that inflation could be accelerating, that may not prevent a September cut, especially if signs of a soft labor market continue, but could present challenges for policy makers later in 2025 if they have to choose between restraining inflation and supporting the jobs market.